April 29, 2003

There are a few guidelines we can follow that will ensure that we get the biggest bang for the buck: high tax-rates and a narrow base. First, the higher the tax-rate the greater the increase in incentives per reduction in tax-rate. To illustrate the sensitivity to the tax-rate level, let's consider an example of a 10% reduction rate, the difference being that we now assume the tax-rate to be 90%. In that case the taxpayer kept only 10 cents on the dollar before the tax cut and 19 cents on the dollar after the tax cut. In this example the tax reduction increased incentives (i.e. after-tax income) by 90%. On the other hand if the top tax-rate had been only 10%, a 10% reduction in tax-rate would have lowered the top rate to 9%, and the taxpayers after-tax take-home income would have risen to 91 cents from 90 cents on the dollar. In short the 10% tax-rate cuts would result in a 1% increase in incentives.The two previous examples suggest that in order to maximize the bang for the buck tax policy should, all else the same, focus on reducing the tax-rates of the highest taxed activities. This is where the double taxation of dividends comes into play.

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